Nadig: Celebrating An ETF Independence Day

In celebration of investor independence and the liberty to pursue ETF happiness...

Reviewed by: Dave Nadig
Edited by: Dave Nadig

In celebration of investor independence and the liberty to pursue ETF happiness...

I consider myself a pretty patriotic guy. Thanksgiving and the Fourth of July are my very favorite holidays. Most years, I participate in a small-town tradition—a reading of the declaration of independence, followed by swimming in the local lake and an old-fashioned barbecue.

I like to think that the reason we celebrate the Fourth of July is less about some sort of thinly veiled jingoism “America! Yeah!” and a bit more about the ideals our forefathers fought for—in short: liberty, the pursuit of happiness and the consent of the governed.

Is it a stretch to think there’s an ETF angle in this? Perhaps, but forgive me the conceit for a minute. Think about the battle that’s been going on for the heart and soul of investing these past 30 years. Matt and I called it a battle between good and evil when we kicked off the year, and I still feel that way.

At its core, liberty is about choices. It’s no guarantee of a good outcome; it’s simply the removal of impediments to self-directed prosperity. Liberty is what makes the pursuit of happiness possible.

ETFs have been an incredible force for liberty in the investing world. Ever since Nate Most cobbled the idea together 20 years ago, the core idea of the ETF has been to get as much garbage out from in between the investor and the market. No 12b-1 fees clogging up your returns. No active management that over-promises and under-delivers. Just the cleanest possible exposure at the lowest possible price.

But ETFs have gone beyond just being cheap packages. They’ve fundamentally changed the way we think about investing in three key ways:

1. ETFs Have Individualized Investing

Think about what it means to have the “consent of the governed.” It means that the big no longer holds sway over the small. In investing terms, it means being in control of every aspect of my own portfolio.

In this regard, the traditional active mutual fund is King George. Mutual funds remain one of the least fair structures ever created. If you want to move in and out of the fund six times this year, I pay your transaction costs, as the fund manager buys and sells securities to deal with your indecision.

Worse, I’ll end up paying taxes for all those capital gains you incurred. Talk about taxation without representation.

The ETF puts individuals back in charge of their own fate. Don’t trade much? You won’t pay for transactions you aren’t making. Don’t incur any capital gains, or better yet, want to harvest some capital losses? You win. There’s nobody at the fund company, or other investors in the fund, messing you up.


2. ETFs Have Broken the Back of Active Management

Look, I get it: There are a few very skilled individuals who can beat the market. But time and time again, history shows us that our ability as investors to select and invest with those individuals at the right times is vanishingly small. But for years, the mutual fund industry has built an institution of obfuscation and balderdash, trying to convince us they were taking care of us.

Some of this is simply made easier by the incredible lack of transparency present in most actively managed mutual funds. One of the grievances from the Declaration speaks to this:

“He has called together legislative bodies at places unusual, uncomfortable, and distant from the depository of their Public Records, for the sole purpose of fatiguing them into compliance with his measures.”

Sounds like how your mutual fund is managed, doesn’t it? When was the last time you heard of the supposedly independent board running your active mutual fund holding the fund manager accountable?

When was the last time you read a report from your fund board saying: “Well, on second thought, it turns out Joe’s Investment Management isn’t very good at picking emerging markets stocks, so we’ve decided to outsource it all to Vanguard.”

The answer is “never.” Supposedly the whole structure of mutual funds is there to act as your representative. In reality, in most firms, it’s a rubber stamp for the will of the fund manager. Why? We can look back at the Declaration for the answer:

“He has made Judges dependent on his Will alone for the tenure of their offices, and the amount and payment of their salaries.”

Nobody gets fired. Everyone gets to collect their check.

It’s true that many ETFs are organized using the same rules as traditional mutual funds. The difference is that index-based ETFs are built using rules that minimize the potential for harm and maximize the transparency of the entire investment management process.

3. They’ve Moved the Responsibility for Returns Back to the Investor

This is perhaps the “uh oh” part that some ETF investors don’t want to hear. With a world of efficient, transparent products at your disposal—and sites like to help you avoid bad apples—you’re out of excuses. If you get rid of the old evil empire, you’re on your own. In the words of the Declaration:

“But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.”

The “new Guards” here are, frankly, you.

You can get help, for sure. You can turn to a financial advisor who can guide you through the market. You can turn to a “robo-advisor” like Wealthfront or Betterment who will hand you a premade portfolio. You can lean on the guidance of economists like Nouriel Roubini, Don Luskin and Marc Faber to help you pick your exposures. But ultimately, you’re the one in charge now.

And honestly, I trust you with a portfolio of ETFs a lot more than I trust those hotshot fund managers from the 1980s and 1990s with their dartboards and itchy trigger fingers.

Contact Dave Nadig at [email protected].

Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.